Euroclear S.A.

Please refer to response submitted by ECSDA.
Please refer to response submitted by ECSDA.
We appreciate that EBA wants a simple measure for the capital surcharge. However, we have reservations on the adequacy and proportionality of the proposed measure for the following reasons:
• The proposal represents a double-counting of the risks, i.e. intraday “peak exposure” will result in a certain amount of “end of day” risk. The latter attracts capital requirements under CRR in any case. As proposed, the surcharge needs to be added on top which means that the capital charge for end-of-day exposure would be included twice in the capital figures.
• The EBA assumes that the default of all participants takes place unexpectedly and exactly on the day and the hour/moment, at which the aggregated exposure for each of the participants peaks (which is totally unrealistic). It is likely that the CSD banking service provider will have anticipated the default of a participant and has been able to reduce credit lines. Moreover, this also assume that all efforts for recovery and resolution of all participants fail.
• As most collateral accepted by the CSD banking service provider will be highly liquid collateral with minimum credit and market risk, a drop of 10% in the valuation of the collateral (on top of the conservative haircut taken into account by the CSD) is a purely theoretical scenario. We even believe that the market value of the highest quality collateral may actually increase rather than decrease due to the likely flight to quality. In addition, if EBA would allow a CSD to use proprietary haircuts, this scenario would penalise a CSD using a conservative haircuts methodology (the higher the collateral haircuts, the bigger will be the impact of a 10% drop). We therefore propose not to use proprietary haircuts, but to use the haircuts as defined in Regulation (EU) No 575/2013.
• The Financial Collateral Comprehensive method of Regulation (EU) No 575/2013, proposes haircuts for different types of collateral and time to maturities, assuming a daily mark-to-market, a daily re-margining and a 10-business day holding period (article 224). As the EBA technical requirements require the collateral to be liquidated on day 1, another 10% haircut for a holding period of 1 day across the different residual maturities, is excessive.
• The proposal to determine one day of peak exposure for a calendar year will make the capital surcharge very volatile from one year to another and difficult to predict.
• There is a clear overlap between Pillar I and Pillar II. EB’s economic capital for credit risk already considers intraday credit exposure. In addition, a capital stress test buffer is added to cover several scenarios. Putting a capital surcharge under Pillar I will reduce the relevancy of Pillar II. Pillar II is more constraining than Pillar I for CSD banking service providers.
• The formula that calculates the capital requirements for the internal based rating approach (article 153 in the CRR) is calibrated for long term credit exposures and not meant to be applied on intra-day (very short term) exposures. We are in favour of a adapting the formula for short term maturities.
We therefore propose to amend the calculation of the capital surcharge as follows:
• Compute the surcharge based on the average of the five largest peak exposures in the preceding calendar year (to reduce volatility of the capital figure),
• Remove from the calculation the end-of-day exposures, which are already subject to standard CRR charges,
• Use the same haircuts as applicable in regulation (EU) No 575/2013. This would ensure that CSD banking service providers use the same haircuts for the surcharge as for their end of day CRR capital requirements and would also ensure consistency between CSD banking service providers,
• Amend the drop in market value to 5% which is more reasonable.
As an alternative, EBA could still consider the simple % capital add-on approach as adopted by FSB for Global SIFIs.
CSD banking service providers will endeavour to have real-time views on positions with cash correspondents. We note however that not all cash correspondents offer such real-time data exchange, and that we may not always have sufficient market power to impose this on our service providers. We therefore request EBA for a proportionate application of this principle.
• Art 18 (1) refers to “collateral is in compliance with pre-arranged funding arrangements as referred to in point (i) of Art 59 (4)”. This seems to assume that there should be a pre-arranged funding arrangement for all collateral. This assumption is not in line with CSDR Art 59(4) points (d) and (e) which do not indicate that pre-arranged funding arrangements are the only possible route to obtain liquidity. We believe this request stems from the misunderstanding of the role participant collateral plays in the liquidity management of the CSD banking service provider (see Part II).
• Art 18 (1) (a) refers to the need to segregate the collateral from other securities of the borrowing participant. EB takes collateral from participants using a security financial collateral arrangement (pledge structure) in the meaning of the Financial Collateral Directive. The pledged securities are held in one or more separately identified pledged accounts of the participant within the books of the CSD-banking service provider and thus segregated from other accounts of the participant.
All securities in a pledged account are subject to the pledge and the securities credited to the account can change until an event of default occurs. This is a characteristic of a floating pledge/charge. In case of excess securities, the collateral taker may select which securities to retain and liquidate (up to the amount of the secured obligation), and which ones to release to the participant. The above way of collateralisation is also desirable as it allows the CSD banking service provider to benefit from additional protection when clients are over-collateralised (i.e. when their credit usage is below the collateral value of assets available in the pledged account).
• To ensure consistency with the Financial Collateral Directive, we propose to clarify that the segregation must take place where the relevant account is held (e.g. with the CSD banking service provider itself) because this is where the right to the collateral is created, i.e. not at the level of any other intermediary
• Art 18 (1) (b). We understand and agree with EBA that CSDs should prefer collateral as defined in Art 19 over collateral defined in Art 20. However, in line with the above explanation, a client that agrees to pledge securities held in a pledged account will legally pledge as collateral ALL securities kept in that account, i.e.:
o Securities that qualify as collateral according to Art 19
o Securities that quality as collateral according to Art 20
o Other securities: even if they do not qualify as collateral and have no collateral value, because they are credited to the pledged account, the CSD nevertheless has the possibility to liquidate or monetise these securities.
o Upon default of the client, the CSD has the right to enforce its security interest against ALL securities in the account (obviously only up to the level of the exposure). We would like to stress that it is absolutely necessary to give the CSD banking service provider flexibility to decide in which priority it will liquidate or monetise the assets as it will need to take into account the market conditions at that moment.
o The “pledge” arrangement has proven to be a very efficient and safe way for CSDs managing the risks of the operator ensuring settlement efficiency in the settlement system because of the built-in collateral substitution possibilities within the account. The CSD will therefore not “segregate” in the pledged account those securities that qualify as collateral according to Art 19 from other securities. The CSD will not manage these securities in Art 19 or Art 20 “buckets”.
o The pledged account is a basket of collateral, and the content of the basket will change according to the participant’s settlement activity, provided collateral of sufficient value to cover the credit extended remains credited to the account at all times.
• For the above reasons, we would propose to amend the language “securities collected as collateral” into “securities provided as collateral”.
• We also propose language to amend Art 18 to reflect the above practice, including a link to Article 36, i.e. the need to include the liquidity aspects of the collateral liquidity in the liquidity stress testing.
• We also note that CSDR level 1 does not require EBA to indicate that high quality liquid assets should be used in priority over other collateral.
• Art 18 (d): requirement to monitor on a near real-time basis the credit quality, market liquidity and price volatility of each security is unrealistic and disproportionate. These characteristics of collateral do not change so often that a near real-time monitoring would be required. Moreover, frequent updating of prices would entail a higher risk of pro-cyclicality. We would therefore propose a requirement to monitor on a daily basis and if required more frequently.
Article 19 – Highly liquid collateral with minimum credit and liquidity risk
Generic comment related to Art 19, 20, 24: These articles include a condition (b) with regard to the currency of the collateral or other equivalent financial resources, i.e. that the collateral is to be denominated in “a currency in which the CSD banking service provider settles transactions in a securities settlement system, within the limit of the collateral required to cover the CSD banking service provider’s exposures in that currency”. We do not believe that the last part of the condition is proportional and needed: it seems to assume that EB can only accept collateral in the currency of the exposure. That would be very constraining. EB does take into account FX risk in its collateral haircut calculation to deal with currency mismatch between collateral and exposure (also included in Art 22 on Haircuts). We propose to drop all instances of the above condition.
Our comments related to article 19:
• As indicated in our comments in Part II, we believe there are sufficient elements of difference between CSD banking service providers and CCPs that should allow EBA to deviate from the EMIR requirements with regard to collateral posted to a CCP. As indicated, EBA should take into account that participant collateral is NOT used in the CSD banking service provider’s day-to-day liquidity management, and that –even in stress situations – CSD banking service providers will have access to other sources of liquidity than participant collateral. This will allow them to bridge potential liquidity gaps until the realisation of the collateral.
• To make the rules more adequate in a CSD environment, we propose:
o In Art 19 (1) (a) (iii): add a reference to Article 118 of Regulation (EU) No 575/2013 (referring to the EU, IMF, BIS, EFSF, ESM)
o Remove Art 19 (1) (c) which includes a requirement for the average time to maturity of the banking service provider’s portfolio not to exceed 2 years. We believe such requirement is not necessary and inadequate for exposure incurred by CSD banking service providers. There is no mandate to EBA to copy the EMIR rules. Restricting collateral in such way could have serious consequences on the market (with possible stress on this limited set of high liquid assets). We would urge EBA to conduct a specific impact assessment on the introduction of this requirement for the CSD environment; the major part of government debt securities has a time to maturity above 2 years (as governments are incentivised by current low interest rates to undertake long term borrowing). We propose to drop the requirement.
o Clarify condition Art 19 (2) (h) (iii): this condition would imply that the CSD banking service provider cannot accept securities issued by entities that are agent banks or cash correspondents. This basically means that the CSD cannot accept any securities issued by major financial institutions. We fail to see the rationale for this requirement which will have significant impact on the eligible collateral for CSDs
o Art 19 (g) requires prices to be publicly available. This unduly restricts the collateral and e.g. some instruments such as commercial paper and certificates of deposit which can well represent good quality collateral.
o Art 19 (h) should be aligned with CSDR Art 59 (4) (e) which refers to collateral that can be liquidated promptly.
o Finally, the text should be aligned with the spirit of CSDR article 59(3) and (4) which refer to “each securities settlement system”. It would therefore be appropriate to refer to “a securities settlement system” in articles 19(1)(d) and 19(2)(c)(ii) of the RTS.
Article 20 – Other collateral
• A right of use is a specific legal right recognized by the Financial Collateral Directive. Therefore we recommend to clarify that article 20(1) relates to “other types of collateral that may be accepted by a CSD-banking service provider”.
• As currently drafted, Art 20 requirements are too strict for CSD banking service providers to have any securities that would qualify as “other collateral”. As indicated before, the possibility to accept such “other collateral” is particularly important in view on non-EU clients that do not have (or which have to acquire) any assets that would follow the EU definition of high quality liquid assets (as defined in Art 19). If we would not be able to accept such other collateral, some of the international business of EB would be at risk (with business moving to entities not subject to CSDR rules inside or outside of the EU).
• It is very important for EB to be able to accept “other” collateral to support its international activities. For certain non-EU clients, not being able to accept government paper from lower rated countries (for example) would mean that our clients would have to increase their risk profile to hold eligible collateral, as they would have mismatched balance sheets at a currency level. They may not even be allowed to do this by their home regulator.
• To make the rule more adequate and practical, we propose to:
o Remove from Art 20 (1) (d) the reference to the pre-arranged funding arrangement that provide for same-day liquidation of the instruments. As indicated above, in case the other collateral needs to be monetised or liquidated, the CSD banking service provider will need to ensure that it has other liquidity sources to bridge the time gap between the default of the client and the timing of the monetisation or liquidation of collateral. Moreover, as condition in Art 20 (1) (b) already required that the collateral be ESCB-eligible, the CSD banking provider will use this route to monetise its assets (i.e. it does not need pre-arranged funding arrangements on top).
o In Art 20 (2) (c), amend the rule such that it is sufficient for the CSD banking service provider can to have EITHER of (i) or (ii), i.e. not a combination of both conditions which have the same objective.
Article 21 – Collateral valuation
In Art 21 (2) (a) (b) (c), we do not understand the requirement for collateral valuation on a real-time or near-real time basis. This requirement is disproportionate and not practical to implement. For example, T2S provides limited possibilities for managing client collateral (e.g. EB can feed T2S only once a day and before 19.00). As most collateral will consist of fixed income securities, the price fluctuations between the two valuations will generally be limited.

Moreover, the collateral haircut as defined in Art 22 is sufficiently conservative to take into account any changes in market value that could occur in the time between two collateral valuations. We therefore propose to remove the reference to real-time and near-real-time basis and propose daily re-valuations at least.
Article 22 - Haircuts
The requirements proposed by EBA represent a significant change in the way EB calculates its haircuts at present as it has to “test” its calculated haircuts with external sources of haircut information. It would mean we have to rely more on a third party commercial haircuts over our internal proven risk-averse haircuts. This would ultimately result in the CSD banking service providers using the risk principles of external providers rather than its own.
We propose the following:
• In Art 22 (2) (b) should be deleted as it is disproportionate. For example, it would have the perverse effect that if the CSD banking service provider has one liquidity provider which applies particularly conservative haircuts – and potentially for a relatively small part of the liquidity funding plan – this would oblige the use of that haircut for the entire collateral portfolio.
• In Art 22 (2) (a) and (b), if the CSD banking service provider does not have or need pre-arranged funding arrangements with a financial institution or central bank, it does not need to establish such arrangement for the sole purpose of determining the haircut.
• In Art 22 (2) (c) the collateral will not be “liquidated” with the central bank but can be “monetised”, i.e. used to generate liquidity.
• In Art 22 (4) on elements to be taken into account for calculation of the haircut, we believe that some of the elements are impractical to take into account, e.g. the bid/ask spread may not always be available.
• In Art 22 (4) point (h) on wrong-way risk “due to correlation between the participant’s creditworthiness and the collateral posted” makes the haircut dependent on the client that posts the collateral. We strongly believe that a haircut should only be defined with regard to the collateral’s characteristics and that any elements related to the creditworthiness of the client should be dealt with in the acceptance criteria of the CSD and the way it sets its credit limit. Point (h) would mean e.g. that the haircut for an AAA-rated government bond would differ depending on the credit quality of the borrowing participant. We urge EBA to drop point (h).
• We do not understand Art 22 (4) point (i) “characteristics of collateral as “other” collateral”. This requirement is in overlap with regard to the other elements of Art 22 (4) as “other collateral” may in any case attract higher haircuts because of points (a) to (g). We believe that EBA should drop point (i) as it is redundant.
• In Art 22 (7) refers to the fact that haircuts should avoid pro-cyclicality. It is unclear to us how this can be achieved as the elements in Art 22 (2) and (4) may all lead to haircuts being increased if market conditions deteriorate which seems to imply some form of pro-cyclicality. We urge EBA to provide more clarity on this aspect.
Article 23 – collateral concentration limits
• Art 23 (3) (e) – we propose to delete “settlement currency” as the settlement currency is not related to the collateral.
• Art 23 (3) (i) – we propose to delete “all borrowing participants” as such limit would assume that the all borrowing participants would default at the same time and all participant collateral would need to be liquidated at the same time which is unrealistic.
• Art 23 (4) (b) – we propose to delete the reference to an internal assessment of the level of credit risk of a financial instrument or issuer. It is unnecessary and practically impossible for a CSD banking service provider to make an internal assessment of all issuers or financial instruments (of which there are several hundreds of thousands).
• Art 23 (5) – the concentration limit of 10% is relevant only when compared to exposure of a particular borrowing participant, not at collateral portfolio level (as the latter would assume that all participant default at the same time and all collateral has to be liquidated at the same time).
• Art 23 (5) (c) – we propose to refer to a commercial entity, to exclude the case whereby the entities covered under (a) or (b) would be part of a state-owned group.
• Art 23 (7) – we propose to delete the latter part of the last sentence as this element is disproportionate and not realistic to implement. We do not see how we would be able to identify undertakings that are essential for the issuer’s business.
As Art 24 is currently drafted, we have two major concerns which will have significant impact:
• The capital of the CSD banking service provider is not considered as an equivalent financial resource, and
• It will have a major impact on the Letter of Credit covering exposure over the Bridge, i.e. the interoperable link between EB and CBL.
In spite of the explicit mention in CSDR recital of the need to remain consistent with global standards, the rules in article 24 are not in line with the PFMIs and such significant impact was not a policy goal in the CSDR level 1.
Capital not counted as equivalent financial resource
• The EBA proposal that excludes capital as other financial resource is not in line with the CPMI/IOSCO Principles for Financial Market Infrastructures (PFMIs) - Principle 4 - paragraph 3.4.6.) and contrary to the basic concept of capital requirements underlying Basel capital requirements. Recital 6 of CSDR Level 1 is explicit of the need to remain consistent with global standards. Capital is the best and ultimate support to cover any decrease of assets value. Moreover, the capital surcharge for CSD banking service providers as proposed by EBA is being defined exactly to cover those situations where collateral would not be sufficient or available to cover credit exposures.
• The entities that currently receive credit that is not collateralised but covered by EB capital are typically central banks, supranational institutions and very highly rated (A /AA rated) financial institutions. They provide liquidity to investment banks in the EB overnight settlement process.
• The impact of the EBA standard is that these clients will need to ensure they collateralise their credit line. For some central banks and supra-nationals (including the European Stability Mechanism) this will be challenging as they are often by law not permitted to put up their assets as collateral. The result therefore, will be that EB will no longer be able to provide credit to those entities - which means that the credit needs of investment banks will increase which cannot be the policy objective.
• We therefore propose that EBA allows the CSD banking service provide to use capital as an equivalent financial recourse in line with the PFMIs.
Impact on the Letter of Credit for the Bridge
• Art 24 (2) (a) limits the amount of a commercial bank guarantee to cases whereby the settlement value is below 1% of the settlement value of the SSS. Settlement values are not an adequate proxy to limit the use of a Letter of Credit as the underlying credit risk is not directly related to settlement values. Any metric would need to be looking at credit exposures.
• Art 24 (2) (h) requires such commercial bank guarantee to be backed by collateral by the provider of the guarantee. This basically means that EBA does not accept the validity of commercial guarantees as credit risk mitigation. The Bridge Letter of Credit is underwritten by a consortium of high credit worthy credit institutions which each subscribe for a limited amount. We are unaware about concerns being raised by the European Commission, Council and European Parliament on this aspect.
• Art 24 (2) (h) (iii): requirements to include the CSD Management Body (i.e. Board) are excessive and not proportionate. We propose to amend and refer to risk committee.
• Art 24 (2) (i) refers to the need for the letter of credit to be honoured within one day. We believe this condition is not realistic. Instead, the CSD banking service provider should ensure that it has sufficient other liquidity arrangements to bridge the gap until the letter of credit is honoured.
These elements are not proportionate and will have significant impact on the cost and/or efficiency of the Bridge which is often praised as the only model of CSD interoperability in the EU, with proven efficiency over more than 30 years. We do not believe EBA can decide on such a major change to existing market practice based on its CSDR Level 1mandate.
We are not sure we understand this question and would like to discuss with EBA.

The assets EB holds to satisfy the LCR are its own assets. EBA seems to assume that EB would use HQLA provided by participants as collateral to fulfil its CRR requirements on LCR. This is not the case. Participant assets held in pledged accounts continue to be owned by participants. It is only upon enforcement of the collateral right, i.e. in case of default of the participant that EB can enforce its rights over the collateral assets.

Unlike commercial banks, EB does not perform maturity transformation: both its assets and liabilities are very short term, generally intraday. Therefore, with regard to CRR - LCR, EB only needs a limited amount of HQLA, i.e. to cover the difference between the 75% of the cash inflows and the cash outflows. Without the 75% limit on the cash inflows, EB would not have any liquidity gap and hence not need to keep HQLA. The HQLA that EB holds for CRR purposes does not come from the collateral posted to it by borrowing participants. The EB treasury will seek to obtain sufficient HQLA by e.g. entering in reverse repos for EB’s own account or investing EB’s capital into HQLA securities (as per CSDR Art 46).

As noted before, EBA also seems to assume that collateral provided by participants would be the main source of liquidity with regard to intraday liquidity risk. This is not the case. The below table shows an extract of the EB Bank CPSS/IOSCO disclosure framework report (extract from 2015 version which is in preparation). It explains the liquidity sources used by EB.
Ilse Peeters
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